An Instrumental Variable Consistent Estimation Procedure

to Overcome the Problem of Endogenous Variables in

Multilevel Models
Neil H Spencer
University of Hertfordshire
Antony Fielding
University of Birmingham
& Multilevel Models Project, Institute of Education, University of London
The Problem of Endogeneity
It is far from unusual for a multilevel model to contain a regressor that can be
regarded as an endogenous variable. The term endogeneity as opposed to exogeneity
is a familiar term in econometrics. Often it manifests itself by explanatory variable
being subject to the same influences as the response variable. It is thus not exogenous
in the model being fitted. More particularly it may mean that variables which are
regarded as endogenous are not independent of the random effects in the model. In
such circumstances a basic assumption of modelling is not met and obtaining
consistent estimators of the parameters is not straightforward. Many standard
multilevel procedures (e.g. Iterative Generalised Least Squares) rely on the
independence of regressors and model disturbances for their consistency properties.
Obviously in the case of the presence of endogenous explanatory variables this does
not generally hold. We present here a modelling strategy based on instrumental
variables and introduce a MlwiN macro that provides desired consistent estimators.
We will consider an example in which we wish to use a multilevel model and where
we suppose an explanatory variable may be endogenous. Fielding (1998) introduces a
dataset drawn from children in primary schools of the City of Birmingham Local
Education Authority. Data is available on a range of school and pupil characteristics
but of prime importance are factors influencing the results of National Curriculum
Key Stage 1 tests. In a simple model we may wish to relate one of these test results
to gender and age of the child in months taking into account as controls the results of
baseline tests carried out when the child entered reception classes in school. A model
such as this may be used to examine the progress children are making in different
schools. For pupil i in school j and where we have p baseline test results we may
write a model which we label (1) as

= =
+ + + + + + + + + + = =
p
1 k
ij j ij ij 2 ij 1 0 ij
u ) k ( TEST BASELINE AGE GENDER TEST 1 KS
The term u
ij
in model (1) represents a random school effect and
ij
is a within school
random pupil effect. The endogeneity in this model arises because the baseline tests
may be supposed to be related to the random pupil effect through the existence of
important unmeasured and unmeasurable influences acting at this lowest level of the
hierarchy ( e.g. home circumstances). These influences are incorporated in the
disturbance
ij
but may also influence baseline test performances. It is also possible
that there are some influences that make the baseline tests related to the school effect
u
j
. The common influences may be such things as the locality in which the school is
situated and from which the pupils generally come.
Overcoming the Problem of Endogeneity
Solutions to the problem of inconsistency caused by endogenous regressors ,
particularly when they are thought to relate to higher level effects such as u
j
, have
been proposed by Kiviet ( 1995) and Rice et. al. ( 1998). Kiviet uses a bias corrected
version of the least squares dummy variable estimator (LSDV). Rice use conditioned
iterative generalised least squares ( CIGLS). The first of these approaches suffers
from a problem that the bias correction applied may actually increase the bias in some
circumstances. Neither approach can directly easily cope with the case where the
level 1 (pupil ) random effect is correlated with regressors. It is this latter situation on
which we mainly focus.
In econometrics and other literature a frequently used method of overcoming such
endogeneity problems in fixed effects models is to use instrumental variable
techniques. We adapt these techniques to cover multilevel random effects models.
The latter possibility has been mentioned briefly and independently by Rice et. al.
(1998). Spencer ( 1997) also suggested such an approach for repeat testing in
educational situations where explanatory variables are lagged versions of the
response.. Here we operationalise an instrumental variable approach by constructing
instruments for each of the endogenous variables ( baseline tests) in model (1)
above. Separate multilevel models for each endogenous explanatory variable are
constructed using regressors assumed exogenous and independent of the random part
of model (1). Prediction estimates of the endogenous variables are then obtained
from the fixed parts of the supplementary models. These predicted values, being
independent of the random part of the model of interest (1), are used as instruments.
Armed with data on the original set of regressors of model (1) and the set of
instruments ( being the original regressor set with endogenous variables replaced by
their instruments), we can conduct an instrumental variable estimation of the fixed
effect parameters in model 1 ( see e.g. Bowden & Turkington (1984)). This provides
us with consistent estimates of the fixed parameters but at this stage adequate
estimates of their standard errors are not available.
The next stage , then , is to obtain estimates of the random part of Model (1). This is
done by using MlwiN procedures to create constraints on the fixed parameters. They
are forced to be equal to those calculated from the instrumental variable procedure.
The resulting estimates of the random part of the model can then be used to obtain
standard errors of the instrumental variable fixed effects estimates.
Mln and MlwiN macros called IV have been written to implement this procedure for
obtaining consistent parameter estimates via instrumental variable estimation. They
are available from the author's on request ( A.Fielding@bham.ac.uk ,
N.H.Spencer@herts.ac.uk ) or can be downloaded from the Birmingham web page
www.bham.ac.uk/economics/staff/tony.htm. Preparatory work on the part of the user
involves identifying which variables are to be endogenous and creating appropriate
instruments for them. Model (1) or whatever is set up in the normal manner in
MlwiN. The macros then need to have indicated to them which worksheet columns
the set of instrumental variables occupy. Following the set of simple instructions in
the 'READ ME' file accompanying the macros does this.
The Application
We now use the example and data of Fielding ( 1998) discussed above to demonstrate
the use and performance of the instrumental variable method embodied in the macros.
The particular response variable used is the Mathematics Test level at Key Stage 1
standardised to have mean zero and unit variance.
The seven baseline tests available in the data ( various forms of Mathematics and
English tests) are inevitably highly correlated. To avoid potential multicollinearity
and for heuristic purposes principal components are formed. The first principal
component accounts for 60% of the variation in the data and none of the remaining
components accounts for more than 8.5%. A decision was taken to use just the first
principal component and this turns out to be a near equally weighted average of the
seven original test scores. This variable was taken as endogenous and replaced the
seven variables in model (1) above. Further, it was then modelled using a multilevel
approach with intercept random effects for school and pupils with fixed effect
explanatory dummy variables for the pupils ethnicity and first language.
Excluded from use were some dummies that had been shown by Fielding (1998) to
have a significant effect on pupil progress. Fielding also found that whether or not the
pupil had been to a nursery school did have an impact on baseline performance but no
significant effect on progress.. Thus a dummy for this variable was also used in
forming the instrument.. The resultant model for the principal component of baseline
scores was thus thought to provide predictions as an instrument, free of the problem
of dependence on the disturbances of the original progress model of interest.
Table 1 shows estimates of the fixed parameters ( and estimated standard errors)of
the adapted model (1) obtained with and without the consistent instrumental variable
estimation procedure ( IV). It is noticeable that the influence of gender and baseline
testing decreases and that of age increases ( indeed almost doubles) when the
consistent procedure is applied. Thus although the estimates from the two procedures
are not radically different the interpretation of the results is affected by the choice of
estimation method. Additionally using the instrumental variable technique gives us
the added benefit of providing estimates which are consistent. Had we not used the
consistent estimation procedure we would not have known the extent to which the
potential problem of endogeneity was affecting the results that we were obtaining.
Table 1: Results with and without Instrumental Variable Procedures
Without IV With IV
Coefficient for Estimate Est std err. Estimate Est. std. err.
Intercept -0.0671 0.0520 0.0353 0.0611
Male gender
dummy
0.102 0.0244 0.0758 0.0335
Centred age in
months
0.0145 0.00379 0.0281 0.00828
Baseline Ist
Principal
0.314 0.00775 0.211 0.0540
Component
In Table 1 it is also noticeable that the estimated standard errors produced by the IV
procedures are higher ( though not much higher ) than those produced without. A well
known drawback of IV procedures is that if good instruments for the endogenous
variables cannot be found , then the resulting estimates , although consistent, may be
quite imprecise. In some cases standard errors can become so large so as to make
results uninterpretable. This in turn has implications for good practice in data
collection where modelling such as that described above intended. Sometimes
information may not be collected on variables which may be important in this respect
but are ignored because they are thought from theoretical and empirical
considerations a priori to have no direct influence on a response The variable of
interest. The relatively low standard errors for the IV estimators displayed in Table 1
may be noted . They were obtained because the instrument for the baseline principal
component variable
was constructed from a number of useful variables that were collected alongside the
baseline results. These variables had no net direct effect on the response once other
controls had been included and could not be part of unmeasured variation included in
the random part of the model. Had these details of nursery attendance and
ethnicity/first language not been available, the estimates of the first principle
component used to construct its instrument would inevitably have been much cruder
and larger standard errors than those in Table 1 might well have resulted. It is also
possible that ,if a much wider range of information relevant to baseline results had
been available, the precision of the IV estimators might have been further improved.
Experimentation with good instrument selection depends on the availability of such
information. There is then a real lesson to be learned for study design. It is important
when studies are planned , with ends similar to the above in view, that allowance is
made for the necessity to have sufficient ( and possibly relevant ) background
variables to use when constructing instruments.
Conclusions
The problem of inconsistency caused by the presence of endogenous variables in a
multilevel model has been identified and a solution suggested by use of adaptations
of instrumental variable procedures. The implementation of the consistent estimation
method suggested has been made possible using the flexible macro facilities of
MlwiN. These macros , available from the authors , make the implementation as a
MlwiN procedure a fairly routine operation. An illustration of the method in action
has been presented and the results contrasted with those produced when the problem
of heterogeneity is ignored. Due to the availability of some reasonable variables with
which to form instruments the IV procedure produced satisfactory efficient estimates.
The importance of sound planning in decisions on data needs have been emphasised.
References
Bowden, R.J. and Turkington, D. A. (1984). Instrumental Variables, Cambridge,
England, CUP
Fielding, A. (1998). Why Use Arbitrary Points Scores? Ordered Categories in Models
of Educational Progress. Discussion Paper 98-23, Department of Economics,
University of Birmingham
Kiviet, J. F. (1995). On Bias, Inconsistency and Efficiency of Various Estimators in
Dynamic Panel Data Models. Journal of Econometrics, 68, 53-78
Rice, N.. , Jones, A. and Goldstein, H. (1998). Multilevel Models where the Random
Effects are Correlated with the Fixed Predictors: A Conditioned Iterative
Generalised Least Squares Estimator ( CIGLS). Multilevel Modelling
Newsletter, 10, 1, 7-11
Spencer, N. H.. ( 1998) Consistent Parameter Estimation for Lagged Multuilevel
Models, University of Hertfordshire Business School Technical Report 1 ,
UHBS 1998:19